Let’s start the new year with some good deeds. For self. And, while I am at it, let me also explain why. Be mindful, my intent is solely driven by the goal of keeping my credit score (being new to the US and all) in check so I won’t be doing something out of angst. Okay, maybe I did intend to get rid of lenders who acted un-cool with me. But wasn’t I looking for an excuse anyway? Awesome!

Before you read further, please read the standard disclaimer¹.

If you have read my previous article about credit score management and the nifty details that make up a credit score, you would no doubt remember that a credit card that has low credit limit hurts your credit score more than it helps you.  There could be other reasons too

When to cancel a credit card?

1. When a credit card has outlived its usefulness. As an example, if you opened a credit card with the specific purpose of doing a 0.0% or other low APR balance transfer and the lock-in period has expired, it may be a good idea to look at what the current/normal APR is. For example, if the introductory APR was low or 0.0% and the current APR is much higher, there is no use holding /using that credit card anymore.

2. When the lender has revised the terms on your credit card from the original agreement. As an example, American Express has repeatedly (4 times in the past one year) brought down my credit limit from $16000 to $1000, citing the excuse of “too short a credit history.” Not to sound pissed but a realistic look at how it affects my credit score would be as follows. If my original credit limit was $16000 about a year back, this account was raising my overall credit limit by a huge amount. However, because this account is now the lowest credit limit, it is instead contributing negatively by bringing down the average available balance(Sum of all credit limits available divided by total number of accounts open).  It is very easy to realize that the numerator in the calculation here isn’t contributing much so, closing an account would be benefitted more by the decreasing denominator.

3. When a lender or its backer’s financial state changes. Levitz went bankrupt. Wamu was acquired by Chase. In this world of financial turmoil, you would be better advised to watch out for change in terms, services and ill favored amendments to your account. Just because two lenders become one should not mean that your utilized credit increases for any lender. As an example, Chase seems to have influenced the promotional APRs for my Wamu account (ever since Wamu was acquired by Chase). Coincidence? Maybe, but I’m always wary of well-timed disfavors. Also keep an eye out for lenders that go out of business. An inactive account stops helping your credit score after a while and may in fact suddenly lower your credit limit (and thus the credit score). Another case in point, know who’s lender/financial arm is who. If a merchant card (say Amazon) is issued by Bank A and you have a high balance on another separate Bank A’s credit account, don’t be surprised to see your Amazon account get impacted.

4. Too many accounts of one type. A good credit score is possible with a mix of multiple account types, with a good balance and a history of on-time payments and sensible, diversified financial management. Having too many accounts open for say revolving credit, even with a high overall credit limit may not always bump up your credit score, in fact it may dent it downwards for missing financial experience on other types. Diversify!

5. Merchant cards are the biggest culprits in terms of lowering one’s credit score and denting finances. I may be wrong but they usually have very high APRs, low limits and are issued by the same banks that you might already have another account with. All three reasons apart, the discount that you actually receive for having merchant cards is either not worth the extra dent they put in your credit score or, can always be received by other means (such as coupons etc). The only exception to this experience is when a merchant card allows promotion APRs for a certain period for purchase of specific items and even though it may be a good deal, the three other factors far outweigh the lone single benefit of owning a merchant card. Not to mention, there is another sinister reason to stay away from a merchant card – Let’s say you have a Frys Credit card and saw a really good camera for $1000 available on a 6 months, no payment, no interest finance plan. You buy it and the store clerk convinces you to buy warranty throughout the life of the finance plan. You also pickup a flash card memory along with that cost you $28, happily swipe your card, sign the agreement  and go home. Slim chances that anyone would realize that they’re paying a whopping 24% or more APR on the extra warranty and the purchases that were not part of the finance plan (which applied only to the camera).  The reason is simple. In fine print on most revolving card agreements, it is stated that the payments you make every month would be first applied to the lowest APR first. In this case, you would have multiple APRs on the card account until the entire balance is paid in full. Something as simple as paying separately (cash or other card) should have precluded this from happening. Then again, if you are using a merchant card for large purchases, you basically should not use it for anything else until it is paid in full either. But, would you remember the next time you hit Frys?

All said and done however, make sure that you

NEVER EVER close a card when ANY of the following is true:

1. It is your oldest card account.

2. It is not the lowest or the 2nd lowest credit limit card

3. You have less than 3 revolving accounts. A revolving account does not always have to be a credit card – it may be your overdraft line or such accounts.

4. If by closing the card your average account age (sum total of months of each credit card divided by the number of revolving accounts)  reduces.

5. If by closing the card your average available balance (sum of all available balances divided by the number of revolving accounts) reduces.

You may also be interested in reading:

How and when to cancel a credit card: Get Rich Slowly

Credit Score Management 101s

Oh, and this article is not yet complete, I will update with details of how cancelling a credit card affects your credit score. I’m expecting a slight hit.

Update: Jan 28, 2009

I was right on the mark to close the Amex card. My score jumped by 7 useless points. Ha!